The impact of trade opening on developing Asia: Evidence and policy implications

Even though in aggregate, trade leads to economic gains, it almost always creates winners and losers. To design appropriate social protection policies, it is important to know the identities of these winners and losers. These policies need to be in place for equity reasons as well as to build and sustain support for free trade.

To determine the identity of potential winners and losers, we can divide the population in several different ways. For example, for every good produced, we have two main groups, namely producers and consumers. In this context, what researchers have found for the various Asian countries they have studied is that trade liberalization improves productivity through greater competition from imported products as well as through cheaper and a greater variety of inputs. They also find the input channel to be the stronger of the two. At the same time, trade liberalization affects price-cost markups. While greater competition through trade lowers the monopoly power of domestic firms and reduces these markups, cheaper inputs give firms or producers the scope for greater profit margins and markups. The net effect of these two channels results in lower prices faced by consumers and improvement in their welfare. At the same time, due to the dominance of the input-related channel, firm profitability could also go up.

Moving to poverty and inequality, there have been huge reductions in poverty all over Asia arising from opening to trade. The two largest Asian countries, the People’s Republic of China (PRC) and India, have experienced large reductions in poverty, brought about by their impressive growth since liberalizing their trade regimes. The PRC has had a better performance than India in both growth and poverty reduction. However, while both have witnessed an increase in inequality, the PRC’s rise in inequality has been much sharper. While the World Bank’s $1.90-a-day poverty rate for India in the 1980s was about 55%, it is about 20% now. The PRC, within the same period, has brought down its poverty rate drastically from almost 70% to 1% now. The Gini inequality index for India has increased from 32 to 34, while for the PRC it has gone up from 28 to 42. While the ratio of the top 10% to the bottom 10% within the last 3 decades increased from roughly 7 to 8 in India, it has increased from 6 to 18 in the PRC.

Many researchers have concluded that given the right kinds of complementary conditions, such as a high road density, a large number of good ports relative to the size of the country, and flexible labor market regulations, trade liberalization will have a favorable impact on poverty reduction. Standard trade theory predicts that the abundant factor (low-skilled labor in the case of developing Asia) will benefit from trade liberalization, thereby reducing both inequality and poverty, but this channel may not always work in practice due to frictions that prevent free intersectoral labor mobility. The proximate cause for the poverty reduction we see after trade reforms in many Asian countries is most likely economic growth. However, greater imports of intermediate and capital inputs, which are complements for high-skilled labor but substitutes for low-skilled labor, may have led to higher inequality.

Next, moving to the wage and employment effects of trade reforms, researchers have not found any adverse impacts so far for the few Asian countries studied, namely India, Indonesia, and the Republic of Korea. This is in sharp contrast to the non-Asian countries studied, which have seen some adverse effects. As a result, we need to exercise caution in generalizing the positive effects for the remaining Asian countries for which there are no studies. Besides, we need to look at the impact on average job quality, an inverse measure of which is the extent of informality. The available evidence for India clearly shows that in the presence of restrictive labor regulations, import competition increases informality. Coupled with the evidence of complementarity between trade and labor-market flexibility also in some of the Latin American countries, we can expect labor reforms to restrict, if not reverse, the informality-increasing effects of trade reforms. It is interesting to note here that in contrast to the impact of import competition, export expansion seems to reduce informality, as seen in the case of Viet Nam.

Let’s next move to the issue of labor adjustment or mobility costs for workers, which also have significant implications for realized national gains from trade. These costs, incurred by a worker from moving from his/her current employment to another sector, turn out to be a few multiples of his/her annual average wage: roughly 4 times the average wage in South Asia and Central Asia and 3.5 times in East Asia and the Pacific. Looking at individual countries, the labor mobility cost is just below 3 times for India and the PRC and close to 5 times for Bangladesh, compared to between 1 and 2 times for developed countries. As a result, a sizeable proportion of the potential welfare gains from trade are being wiped out in Asia. In the relatively low-mobility-cost developing countries like the PRC and India, about 10%–15% of the potential gains from trade get wiped out, while in the high-mobility-cost countries like Bangladesh and the Philippines, about 33%–50% of the potential gains are eliminated.

Researchers suggest several policy options to reduce these adjustment costs. These policies include subsidizing destination-specific relocation costs, training programs to provide skills specific to destination sectors, unemployment benefits or insurance, job search assistance, subsidized employment through public works programs, announcing trade reforms in advance or gradual trade liberalization that would allow for advance planning, and relatively less stringent restrictions on the firing of workers. These policies can also be useful in addressing several other distributional effects of trade reforms that are found in various studies in the form of trade’s impact on labor-demand elasticities, the bargaining power of workers, and wage inequality, etc., as detailed in my recent ADBI working paper.